Top 5 decentralised exchanges and how they work
The signs of early panic began on the 12th of January as Twitter mentions of @krakenfx rose, coupled with ever-increasing references to Mt. Gox, whose 2014 hack led to a loss of 850,000 Bitcoins and depressed the value of the cryptocommodity for years afterward. The panic surrounding Kraken, the largest exchange in the world for EUR denominated trading, mounted as the initial ‘planned maintenance’ of 4 hours stretched to over 48. Kraken reassured users that funds were safe and the platform had not been compromised, but it wasn’t hard to draw comparisons to the earlier Bitfiniex hack or the Mt. Gox hack, which took days to uncover. Bears were convinced a hack had occurred, painting a big target on the exchange’s Bitcoin and Ethereum hot wallets, which had held millions of EUR worth of the two currencies.
Such a hack at a centralized exchange would invariably tank the price of the commodities, compounding the actual losses to every single user on the platform. And for it to happen to Kraken, which had been considered the prime standard for security, would be catastrophic. There was, of course, no hack. Kraken had trouble with the planned upgrade, and even removed all fees from the platform to make up for the downtime but this did little to defuse the panic-selling or the lawsuits which had been threatened.
In the wake of the not-hack, public opinion surged again in favor of hardware wallets. Centralized exchanges, even the most robust, were always susceptible to being hacked, and an offline wallet would at least protect your holdings – but this only provided an option for safe storage, not for trading. How would one keep holdings tucked away safely while also trading when required?
Enter decentralized exchanges
One of the major selling points of blockchain technology is the ability to disintermediate and remove centralized control. Why, then, could the exchanges trading these assets not be decentralized themselves? If the exchange did not exist in a single physical location, apart from the immediate safety for stored funds, it would also become less vulnerable to governmental censorship (China, for example, would not be able to ban Bitcoin twice a year any more). An exchange existing as a decentralized network of nodes could only be shut down if every single node were taken down. Such an exchange would be the logical step ahead for trading these assets.
The decentralized exchange (DEX) ecosystem is still very much in its infancy, but there are some that are already usable. Most of the interfaces are still clunky and there aren’t dedicated companies or teams working on all of these to provide customer support when required. As DEXes rely on recording transactions directly on the blockchain, the transaction speeds are far lower than what a centralized exchange might provide while also resulting in higher fees during peak times. Together, these factors also result in significantly lower volumes being traded across these exchanges. However, if safety is a priority, using a decentralized exchange is a necessary tradeoff. Some of the currently active DEXes are discussed below.
Bisq is a fully open-source client that can be downloaded and used for trading. This is one of the few exchanges that allows trading with fiat currencies as well as other cryptoassets. Bisq allows the use of BTC, DASH, DOGE and LTC as base currencies when trading.
Bitshares / Openledger / Cryptobridge
Bitshares and its derivatives allow the trade of any asset pegged to their own native currencies (Bitshares or Bridgecoin). While these are DEXes by design, the need to buy an additional token just to trade on them is an unnecessary additional step in their usage.
Catering exclusively to Ethereum and Ethereum-derived ERC-20 tokens, Etherdelta has been the most prominent exchange of late, fueled by the rise of ICOs and ERC-20 tokens. Built using smart contracts on the ETH blockchain, this is as close as it gets to trading natively on the blockchain. However, Etherdelta was the victim of a recent DNS hack that resulted in the loss of funds for many users. This raises an important concern for users: while DEXes are robust as long as the underlying platform or smart contract is foolproof, the access points of DEXes (through your web browser) can still be tampered with. Extreme vigilance is required on the part of the user to ensure they’re not looking at a hacked version of the website, but this isn’t always easy to discern. While the Etherdelta hack required users to provide their private keys a second time (which was a clear red flag), not every user has the awareness needed to identify malicious actions on a DEX.
Idex is a marked usability improvement over Etherdelta that allows the trading of ERC-20 and ETH tokens. The addition of the AURA token (similar to how Bitshares or Bridgecoin provide rewards) allows users to benefit from increased usage of the platform.
Also catering to ETH and ERC-20 tokens, Radar Relay is built using the 0x protocol. An added advantage over Etherdelta or IDEX is that no withdrawals or deposits are needed for using the exchange, lowering the chance of misplaced funds.
Using any of these exchanges follows the same set of steps:
1) Create a separate wallet that you control the private keys to. Use MEW, Metamask or a hardware wallet to interact with your address.
2) Link your wallet address to one of the exchanges through the use of a private key, Metamask or a hardware wallet.
3) If an intermediary token is required, buy the token using stored ETH.
Adding a layer of security to DEXes
DEXes are definitely safer than traditional centralized exchanges but are still dependent on the user exercising caution when trading. A relatively simple extra step would be to use offline wallets (paper wallets or hardware wallets) as an additional security layer. Exchanges such as Etherdelta and Radar Relay even allow for the direct linking of hardware wallets to the trading contract. Such a setup would give the user complete trustless control over their holdings – from the storage to the trading of tokens – without dependence on a centralized server or service.